We spent a lot of time in managerial accounting
and talking about costs.
So let's switch our focus for a moment to price.
There are a number of factors that affect a product's price,
but the basics of pricing comes from ECON 101.
Supply curves and demand curves intersect
at the market price of a product.
In addition to demand factors, other factors
include pricing goals, like lowering pricing
to increase market share, or cost considerations,
like can we reduce cost to have a more competitive price.
Regardless of the factors involved,
the price must cover the cost of goods or services
as well as earn a reasonable profit.
When it comes to pricing decisions,
companies tend to fall into one of two categories.
Price takers are companies whose products
are not easily differentiated from competitors' goods.
Prices are not set by the company,
but rather by the laws of supply and demand.
Most companies are price takers in a market economy.
This is why Coca-Cola and Pepsi are priced so similarly.
If one was priced much higher than the other,
few would buy it.
This is not true of price setters however.
Price setters are companies whose products
are unique and clearly distinguishable
from competitors' goods.
Therefore, price setters can set high prices
for their unique goods.
Since price takers don't have control over market price,
they have to focus on controlling costs.
Target costing is the difference between the market
price and a reasonable desired profit.
All of the costs incurred within the value chain
to produce and sell a product are
included in the target cost.
When actual costs are less than target costs,
a company can produce and sell the product.
However, when actual costs are higher than target costs,
a company must make some changes before selling its products.
Let's look at an example.
The Talking Heads are price takers
and have a desired profit on a newly released single
of $10,000.
They have discretionary fixed costs related
to album marketing of $25,000.
All other costs cannot be changed.
Target costing analysis shows that the target cost
is less than the actual cost.
So the Talking Heads would either
need to accept a lower desired profit
and/or cut discretionary fixed costs.
Price setters use a cost-plus pricing rather than
target costing.
Cost-plus pricing starts with the full product
costs and adds the desired profit.
Lets look at this example.
The Talking Heads are price setters
and have a desired to profit on a newly released single
of $10,000.
Their costs related to the singles are shown on the slide.
With their full product cost and desired profit,
they want to earn a total revenue of $135,000.
If they intend to sell 500 copies,
then the cost-plus price is $270 per unit.